Annual report pursuant to Section 13 and 15(d)

Fair Value Measurements

v2.4.0.6
Fair Value Measurements
 12 Months Ended
Dec. 31, 2011
Fair Value Disclosures [Abstract]  
Fair Value Measurements
Fair Value Measurements

Fair value is defined within the accounting rules as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. The rules established a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. As presented in the tables below, this hierarchy consists of three broad levels:
 
Level 1
Valuations consist of unadjusted quoted prices in active markets for identical assets and liabilities and has the highest priority;
Level 2
Valuations rely on quoted prices in markets that are not active or observable inputs over the full term of the asset or liability;
Level 3
Valuations are based on prices or third party or internal valuation models that require inputs that are significant to the fair value measurement and are less observable and thus have the lowest priority.
 
Fair Value of Financial Instruments

Cash, Cash Equivalents, and Short-Term Investments. The carrying amounts for these instruments approximate fair value due to the short-term nature or maturity of the instruments.
 
Debt. The Company’s debt is recorded at the carrying amount on its Consolidated Balance Sheet.  The fair value of Callon’s fixed-rate debt is based upon estimates provided by an independent investment banking firm. The carrying amount of floating-rate debt approximates fair value because the interest rates are variable and reflective of market rates.

The following table summarizes the respective carrying and fair values at: 
 
For the year ended December 31,
 
2011
 
2010
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
Credit Facility
$
—

 
$
—

 
$
—

 
$
—

13% Senior Notes due 2016 (a)
125,345

 
110,571

 
165,504

 
140,030

     Total
$
125,345

 
$
110,571

 
$
165,504

 
$
140,030


(a)
2011 and 2010 Fair value is calculated only in relation to the $106,961 and $137,961 face value outstanding of the 13% Senior Notes, respectively. The remaining $18,384 and $27,543, respectively represents the Company's deferred credits and have been excluded from the fair value calculation.  See Note 6 for additional information.

Assets and Liabilities Measured at Fair Value on a Recurring Basis

Certain assets and liabilities are reported at fair value on a recurring basis (unless otherwise noted below) in Callon’s Consolidated Balance Sheet. The following methods and assumptions were used to estimate the fair values:

Commodity Derivative Instruments. Callon’s derivative policy allows for commodity derivative instruments to consist of collars and natural gas and crude oil basis swaps, though at December 31, 2011 the Company’s portfolio included only collars.   The fair value of these derivatives is derived using a valuation model that utilizes market-corroborated inputs that are observable over the term of the derivative contract, and the values are corroborated by quotes obtained from counterparties to the agreements. The Company’s fair value calculations also incorporate an estimate of the counterparties’ default risk for derivative assets and an estimate of the Company’s default risk for derivative liabilities.  The Company believes that the majority of the inputs used to calculate the commodity derivative instruments fall within Level 2 of the fair-value hierarchy based on the wide availability of quoted market prices for similar commodity derivative contracts. See Note 7 for additional information regarding the Company’s derivative instruments.

The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis for each hierarchy level:
December 31, 2011
 
Balance Sheet Presentation
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments - current Portion
 
Fair market value of derivatives
 
$
—

 
$
2,499

 
$
—

 
$
2,499

Derivative financial instruments - non-current
 
Other assets, net
 
—

 
—

 
—

 
—

Liabilities
 
 
 
 

 
 

 
 

 
 

Derivative financial instruments - current Portion
 
Fair market value of derivatives
 
$
—

 
$
—

 
$
—

 
$
—

Derivative financial instruments - non-current
 
Other long-term liabilities
 
—

 
—

 
—

 
—

Total
 
 
 
$
—

 
$
2,499

 
$
—

 
$
2,499

 
The derivative fair values above are based on analysis of each contract. Derivative assets and liabilities with the same counterparty are presented here on a gross basis, even where the legal right of offset exists. See Note 7 for a discussion of net amounts recorded in the Consolidated Balance Sheet at December 31, 2011.

Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis

Certain assets and liabilities are reported at fair value on a nonrecurring basis in Callon’s Consolidated Balance Sheet. The following methods and assumptions were used to estimate the fair values:

Asset Retirement Obligations Incurred in Current Period. Callon estimates the fair value of AROs based on discounted cash flow projections using numerous estimates, assumptions and judgments regarding such factors as (1) the existence of a legal obligation for an ARO, (2) amounts and timing of settlements, (3) the credit-adjusted risk-free rate to be used and (4) inflation rates. AROs incurred for the year ended December 31, 2011 and resulting in fair value measurement, including upward revisions to ARO liabilities of $454, were Level 3 fair value measurements. See Note 14 for a summary of changes in the Company’s ARO liability.

Other Property and Equipment. See Note 3 for additional information regarding the Entrada project assets acquired through a wind-down agreement with Callon’s former joint interest partner on the project. During the second quarter of 2011, Callon acquired 100% of the rights to all remaining assets related to the Entrada project, which primarily consisted of surplus equipment not used during the Entrada project. As Callon is required to measure the assets acquired at fair value, Callon estimated each asset’s fair value based on several factors including (1) historical prices received for assets sold, (2) the similarity of unsold assets to those previously sold and the sales prices for those similar assets, (3) the number of market participants expected to have an interest in the assets, (4) the degree to which the asset has been customized and would require modification by a purchaser for use, and (5) the nature of the asset being held for sale (i.e. whether the asset is highly specialized, built-for-purpose, etc.). Values assigned to equipment sold prior to the June 30 reporting date and for which the exit price, as defined by US GAAP, became readily determinable, represent Level 2 fair value measurements and represents $3,954 of the total $11,349 acquired through the agreement. The remaining $7,395 of Entrada assets represent Level 3 fair value measurements based on the limited ability of market pricing information for either identical or similar items. Certain assets were assigned $0 values in instances where the fair value was indeterminable due to the built-for-purpose or highly specialized nature of the assets. Also as a result of this Agreement, the Company assumed liabilities, which consisted of a deferred tax liability associated with the basis difference of the equipment, which was valued at $2,681. During the third quarter of 2011, the Company determined that certain unsold surplus Entrada equipment with carrying values of $690 had become impaired due to the limited market for these assets and based on discussions with potential buyers. Consequently, the Company reduced these assets' carrying value to $348, which represents a Level 3 fair value measurement. See Note 3 for additional information regarding this equipment.